Some buyers getting ‘greedy’ as economy pushes Canadian tech startups towards early exits

Early-stage companies consider selling as capital dries up -- but can they stomach the offers?

A visitor attending the B.C. Tech Summit | Chung Chow, BIV

Awkward conversations with Canadian tech entrepreneurs looking to guide their startups to an early exit have been all too common for M&A expert Brent Holliday the past three months.

Investor interest in the tech sector has been dampening on the public markets, while central banks have been hiking rates across the globe to tamp down on inflation.

The cheap and easy capital flowing freely into the tech sector from venture capitalists (VC’s) the first two years of the pandemic just isn’t there any more, pushing more early-stage companies to seek an early exit.

But the potential selling price of these startups has left some Canadian entrepreneurs stunned, according to Holliday, CEO of Garibaldi Capital Advisors Ltd.

His Vancouver-based firm provides M&A and capital-raising advisory services to tech companies.

“It's extremely difficult. They ask me, ‘What's your valuation?’ I say zero. They say, ‘Well, come on. You know, I must be worth $20 million because I've got this great tech and this great team.’ And I shake my head,” said Holliday. “You've got to go find money, or you've got to live to fight another day or you can elect to go and sell into this market but please expect not a whole lot more than zero.”

The companies he’s getting calls from are typically three to four years old and might be generating $1-2 million in sales annually even as they continue to burn capital.

“They are facing the daunting prospect of raising a Series A [funding round] or Series A extension in this environment where the VC’s are sitting on their hands for new deals,” Holliday said. “It is a universal fact across the tech industry in Canada that everybody's trying to get to 24 months of runway and that means a) cuts and lowering growth expectations, and b) trying to raise more money, likely from your existing investors because new investors are very hard to find.”

Instead, VC’s are focused on funding existing investments to make sure those companies have enough money in the bank to get them through the next two years as central banks try to cool their respective economies amid record inflation.

B.C. firms managed to draw $807 million in venture capital during the first six months of 2022 — down from $1.83 billion during the same period in 2021, according to the Canadian Venture Capital and Private Equity Association.

M&A expert David Raffa said he’s been approached recently by a number of early-stage companies whose boards have asked management to explore an early exit.

“Their thinking is that the current economic downturn is going to make access to capital and growth a challenge over the next 18-24 months,” said the president of Valeo Corporate Finance Ltd., whose Vancouver-based firm provides M&A and initial public offerings services. “So they want insight into what they might be able to sell for today versus bearing the risk of trying to grow.”

Raffa said there are buyers out there hungry to acquire and that the early-stage companies are “thinking exactly as they should be – thinking strategically about their options.”

The profitable tech startups in growth mode are now the “darling of the ball” among those looking to exit, according to Holliday.

The money-losers are mostly being dismissed out of hand by financial buyers.

“Those companies are coming in droves to people like us, and we're shrugging our shoulders and saying these are extremely difficult sale processes in this market,” Holliday said. “Quite honestly, we're in market with two profitable, growing companies and it's been a feeding frenzy. We'd rather sell those companies.”

The money-losers that are being acquired right now are dealing with what’s known as an acqui-hiring. A portmanteau of acquisition and hiring, acqui-hiring refers to when a larger firm will buy out a startup just to scoop up its technology and engineering team, and dump then the rest.

“There are companies that have amazing technology, and have some traction and have maybe 12-18 months of burn in front of them and those ones, the [strategic acquirers] are starting to get greedy,” Holliday said.

“When you're not profitable, the world is not your own, you don't own your destiny. And it is very tough slogging for those companies right now.”